The emergence of new industries, such as semiconductors, biotechnology and the internet, as well as the introduction of innovations in healthcare, information technology and new materials more broadly, have often been driven by the availability of independent venture capital (VC) firms to help finance start-ups.
However, challenges in cleantech has meant VC investments have "begun to move away from radical technologies related to energy production and are increasingly focused on energy efficiency, software, energy storage and transportation", according to Harvard Business School academics Shikhar Ghosh and Ramana Nanda*.
The academics said the VCs’ shift was to invest in areas closer to their traditional model requiring lower capital intensity, quicker exits and more similar portfolio company business models than energy production seemed to require.
The most important factor was the relative length of time before an exit, as a VC fund’s life is often limited to 10 years. To invest in clean energy, therefore, "will require a radical reworking of the VC fund structures and terms" or further government support, the academics added.
This is unless exit horizons, such as through stock market flotations or acquisitions by incumbents, open up more quickly to nascent businesses.
The academics said the clean energy industry was effectively at the same stage as the biotech industry was in 1982 and communication networking in 1988.
Daniel Primack, writer at news provider Fortune, said VCs that invested heavily on clean-tech companies years away from profitability were taking "big bets" that "public markets would fall in love with the idea of clean-tech, much as they had fallen in love with dot.coms a decade earlier".
Primack added: "Then the macro-economic crash occurred, and the capital markets shut for everyone (the deserving and the not). Many VCs were suddenly left to support cap-intensive companies they had never planned to support, thus damaging portfolio values.
"Imagine, for example, if 1998-vintage VC funds had not been able to access the capital markets, and instead were required to hold on to their dot.coms for a few more years. The public market emperors would have eventually recognised the lack of clothes, and gone to a department store. Same thing withclean-tech."
The investors needed to have "significantly larger funds than is typical" with longer lives "so that VCs can nurture start-ups through commercial demonstration and hence bridge the valley of death".
This death valley is found after a start-up has navigated through initially proving its technology works but before it has shown it also works at a commercial scale, at which point project finance debt and industry adoption often comes in.
Managerial issues often compound these dual technological risk time points. Often, executives drawn from incumbent energy firms struggle to deal with start-up realities of fundraising, while entrepreneurs drawn to the sector usually have relative little experience in finding the size of funds needed to take a business into the scale of production.
This has meant less than 30 VCs have specialised clean-tech groups, the academics said. And the top five VC investors in clean-tech have backed a quarter of US deals even as VC investment in clean-tech has risen from $230m in 43 companies in 2002 to $4.1bn in more than 200 businesses in 2008. This $4.1bn was 15% of the total invested by VCs in the US two years ago but in clean energy it is dwarfed by the overall investment rates.
Less than 5% of the $500bn in new investment between 2007 to 2009 was venture capital and private equity investment, with about half coming from project finance, according to Bloomberg New Energy Finance data used by the academics.
* Venture Capital Investment in the Clean Energy Sector, Harvard Business School working paper published August 2010. Electronic copy available ssrn.com/abstract=1669445